Climate Risk8 min read

Carbon Pricing Pass-Through and Corporate Credit Risk

By Jonas Adam Mohamed Osman, known as Yonas Osman

CEO of Quantica Risk

60 Rue François Ier, 75008 Paris, France

Published 15 October 2026

How carbon pricing costs pass through to corporate margins varies by sector pricing power, directly shaping transition risk in corporate credit analysis.

Executive answer

The credit risk impact of carbon pricing on a corporate borrower depends heavily on whether the company can pass the added cost through to customers without losing volume, which in turn depends on sector competitive dynamics, substitute availability, and exposure to international competitors not facing equivalent carbon costs. A cement producer with strong regional pricing power may absorb carbon costs via price increases, while an export-exposed steel producer facing competition from regions without comparable carbon pricing may see margins compressed directly.

Credit analysts assessing transition risk should therefore move beyond a simple carbon intensity metric and assess pass-through capacity explicitly, since two borrowers with identical emissions intensity can have very different credit outcomes under rising carbon prices depending on their market position.

Sector pass-through dynamics

Sectors with price-inelastic demand and limited import competition, such as domestic cement, aggregates, and certain utilities under regulated tariff structures, tend to have higher pass-through capacity, allowing carbon costs to flow to end customers with limited margin impact. By contrast, globally traded commodities like steel, aluminium and basic chemicals face more constrained pass-through where competitors operate under different or absent carbon pricing regimes, creating a genuine competitiveness risk alongside the credit risk.

Mechanisms such as the EU's Carbon Border Adjustment Mechanism are specifically designed to address this competitiveness gap for imports into covered sectors, and credit analysts should track how such mechanisms phase in, since they materially affect the pass-through assumptions used in transition risk scenarios for affected borrowers.

Scenario design for carbon price paths

Transition risk scenarios typically model a range of carbon price trajectories, often drawing on NGFS pathways, but the translation from a carbon price assumption to borrower-level cash flow impact requires explicit modelling of pass-through rates by sector and geography, not just application of the carbon price to reported emissions. A flat assumption that all carbon costs flow to the bottom line without any pass-through will systematically overstate transition risk for sectors with genuine pricing power.

Scenario design should also account for the possibility of free allowance allocation under schemes like the EU Emissions Trading System, which shields certain sectors from the full marginal carbon price in the near term but phases out over time, meaning credit analysis needs a forward view on allowance phase-out schedules alongside the carbon price path itself.

Implications for ratings and covenant structures

Rating agencies have increasingly incorporated carbon cost exposure into sector outlooks and individual issuer assessments, particularly for issuers in hard-to-abate sectors where pass-through capacity is limited and capital expenditure requirements for decarbonisation are high. Credit analysts should expect carbon pricing sensitivity to feature more prominently in rating rationale over coming review cycles as carbon prices in major schemes have trended upward.

Loan agreements and bond covenants are beginning to incorporate sustainability-linked terms tied to emissions reduction targets, which interact with carbon pricing exposure since a borrower facing high carbon costs and ambitious covenant-linked targets carries compounded financial and reputational risk if it misses those targets.

Conclusion

Carbon pricing pass-through is the hinge variable that determines whether rising carbon costs become a genuine credit risk or a manageable cost pressure for a given borrower, and sector-specific analysis of pricing power is essential to get this right. Blunt, emissions-only transition risk scoring misses this nuance and can misallocate risk appetite and pricing.

Yonas Osman, CEO of Quantica Risk, insists that any transition risk assessment built around carbon pricing explicitly model sector pass-through capacity rather than applying a uniform cost pass-through assumption across borrowers.

Primary sources

carbon pricingtransition riskcorporate creditEU ETS